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Wednesday, January 12, 2011

Dead Country Walking?

The Portuguese government is breathing a sigh of relief after today's bond auction, in which Portugal managed to sell €1.25 billion of its debt. Crucially, €599 million of ten-year bonds were sold at an average interest rate of 6.71%, slightly below the 7% threshold which many analysts consider unsustainable (but still high).

However, as we noted before, the risk that Portugal will be forced - sooner or later - to tap the €750 billion eurozone rescue fund remains huge. The country has to raise around €20 billion on the markets this year to refinance its liabilities. The yield on its ten-year bonds reached 7% a few days ago, despite the ECB stepping up its purchase of Portuguese debt, and the question is what is to stop it from rising again.

So the worry is that today's auction is an exception. It's probably not a coincidence that reports of eurozone finance ministers considering a top-up to the the eurozone rescue fund emerged the day before Portugal's bond auction (assuring investors of the EU's fire power). EU Economic Affairs Commissioner Olli Rehn even wrote an op-ed on the topic in today's FT. In addition, the Japanese government - in what can be seen, primarily, as a political response to China - has announced that it will buy 20% of the bonds to be issued by the European Financial Stability Facility at the end of this month, perhaps another calming factor.

So this is positive, but probably temporary. Unless Portugal gets a sudden economic break before the next auction, it may be forced to accept higher interest rates than this time around, making the situation even more unustainable. This is why Alan McQuaid of Bloxham Stockbrockers bluntly says,

Portugal is practically dead already

No surprise, then, that today's FT Deutschlandsuggests that a bail-out package of between €50 billion and €100 billion for Portugal is already being prepared in Brussels....